Among the many tasks necessary to create a successful new world order, after the events of the past several years in Eastern Europe and the former Soviet Union, it will be necessary to transfer ownership rights in substantial portions of some countries' vast state-owned capital stock into private hands. In such countries, as well as others currently lacking effective owner shares markets, it may be desirable to develop policies and tools for operating such owner shares markets. Methods, tools and tasks necessary to accomplish such an enormous economic undertaking, without causing socially destructive economic dislocation is the subject of intense current research.
It is a general goal of the present invention to provide computerized market tools usable in countries which may be lacking market infrastructure. It is a more specific goal of the present invention to make available computerized market tools able to support any privatization policy chosen by government policy makers, including making possible the universal distribution policy outlined below.
The universal vesting in the citizenry of newly democratic nations of ownership in large state enterprises is both desirable and feasible. The current crises in social welfare threaten the transition to free markets and democracy. Large state enterprises are key. They are a major societal asset capable of providing a social "safety net" in addition to a "trampoline" of opportunity. Their effective privatization is a precondition to a free market economy. Universal vesting of the future ownership interest in large state enterprises strengthens the "safety net" and "trampoline" by broadly distributing a major asset. It strengthens the prospects for a free market economy by equitable, fast and effective privatization.
The conventional wisdom which writes off universal vesting as a laudable but unrealistically idealistic objective is wrong. The idea that ownership should be awarded to stakeholders, such as those already fortunate enough to happen to be employed at successful enterprises on the day they go private, would randomly redistribute and concentrate wealth to the advantage of a quite small percentage of the population. Even extremely widespread share-ownership is consistent with management acting in the shareholder interest, by means of polled voting and executive compensation tied to stock market valuation.
Universal vesting can promote the transition to free markets by immediately resolving the legal and economic issue of ownership rights. In the process, it can help legitimize the process of transformation. While entrenched interests and nostalgia buffs remain potent forces, it would seem that the inchoate clout of the entire citizenry is also something to be reckoned with.
The road to democracy can be rocky. For example, there is a real danger of "famine, social upheavals and chaos" in Russia. The result can be catastrophic feedback loops among undesirable social processes. Social disarray can cause famine and epidemics. Famine can lead to mass migrations, the breakdown of sanitation service, and epidemics of infectious diseases. After an initial period of kinship and concern for vulnerable members of society, family and social structures can disintegrate into survivalism and lawlessness, leading to riots, insurrections and revolutions. Even if such calamities are avoided, there remains the all-too-realistic hazard of a decades-long political stalemate which would block economic restructing and positive social transformation. These are dangers which pose a true current threat to international security.
Economic devastation is a major issue in many newly democratic nations. Many of the citizens live in absolute poverty. By some standards, the danger of a depression has already come to pass. The worst-affected groups include the homeless, the unemployed or low-paid, some elderly and most families with three or more children--comprising 25% of the population in Hungary. Over forty million citizens of the former Soviet Union had income below the subsistence minimum. Deindustrialization, which leads to a service economy requiring a more educated workforce, may tend to increase homelessness. In 1988, over 200,000 people in the former Soviet Union were officially cautioned to discontinue a "parasitic way of life"--code for vagrancy, begging and sponging. That same year, 7.5 million elderly received minimum pensions amounting to 55 rubles or less per month.
Children, especially ethnic minorities or those with single parents, and youth seeking first employment, constitute particularly vulnerable classes. In the mid-1980s in the former Soviet Union, divorces left 700,000 children with a single parent each year; 300,000 children lived in state-run children's homes or boarding schools; and 700,000 lived in foster homes. In 1991 in the former Soviet Union, juvenile delinquency increased 20% in a year, 160 hooligan groups of teenagers operated in Moscow, while more than 1,200 organized gangs existed nationwide. There is a danger that an integenerational cycle of declining education and income will create a permanent underclass. A strong social safety net by the government is clearly needed.
A number of policies provide an important, if standard, response to social welfare problems. For example, the social safety net designed by the former Soviet Union to fulfill--with such a noteworthy lack of success--the constitutional right of each citizen to employment, free education and health care was comprised in roughly equal parts of consumer transfers and monetary transfers. Financial reform then dictated the curtailment of enterprise subsidies, causing monetary transfers to increase. But now economic contraction has burdened the system and eroded the safety net.
In reaction, the 1991 Soviet budget trebled the payroll tax from 12% to 37%, in order to finance pension reform and a substantial increase of over 35% in nominal welfare expenditures. To cope with inflation, presidential guidelines indexed wages at from 70% to 50% (declining by income level), and indexed pensions at 100% with tightened eligibility, while providing a minimum consumer basket. The Soviet Employment Law provided for unemployment benefits, job training and public works. Ukrain proposed unemployment benefits of 70% of the last wage for 3 months after price liberalization, 50% for the next 6 months, falling then to 40%, but no less than the minimum wage nor more than the average wage.
Many of the policies now needed to attempt to maintain a viable social safety net, in the context of extreme budget constraints, are straightforward even if difficult to implement. Eligibility criteria need to be tight. Delivery of services must be efficient. Western aid must be coordinated effectively. A "food" stamp program should replace price controls of even essential goods such as bread and energy, in order to allow complete price liberization. School meals should be fully maintained, while food kitchens and other basic services by private organizations should be strongly encouraged. Physical and personnel defense assets should be evaluated for social service, perhaps organizing decommissioned soldiers into a domestic service corps.
The United States experience with the New Deal "alphabet agencies" designed to combat the Great Depression should be carefully evaluated as unemployment swells. The Civil Works Administration (CWA) hired more than four million workers within three months. The Public Works Administration (PWA) sought to revive construction and restore the infrastructure. The Works Progress Administration (WPA) built 617,000 miles of new roads, and built or repaired 124,000 bridges and viaducts, 120,000 public bridges, and 30,000 stadiums, parks, playgrounds and athletic fields. The Civilian Conservation Corps (CCC) hired jobless youth and young adults for conservation projects. The National Youth Administration (NYA) employed 800,000 at its peak with an out-of-school program resembling the WPA, and with an in-school program of part-time jobs to reduce competition with adult jobseekers.
President Roosevelt stated critical guiding principles: the "alphabet agencies" should pay more than welfare but less than private employment, while serving as many needy people as possible with the available funds. Congress has subsequently mandated that jobs programs should provide useful services and meaningful employment without displacing private employment or government operations.
It is paradoxical that the explicit goal of the newly democratic nations--the destatization of resources and employment--may be accompanied by massive government works projects. It is important that this paradox be resolved by emphasizing Roosevelt's guiding principles and the Congressional mandate: jobs programs should be designed as temporary support and focused training rather than assured carriers.
Large state enterprises are typically of central importance in the economies of newly democratic nations. For example, the state sector of the former Soviet Union represented 96% of the "value added" in commerce and industry Soviet state firms accounted for 90% of industrial employment. Subsidies commanded by state enterprises there reached macroeconomic importance at 18% of GNP. But since this has roughly equaled revenue from enterprise taxes and transfers, to a first order approximation privatization with hard budget constraints would not affect the budget deficit, or the state's ability to finance the social safety net.
State-owned industrial enterprises are typically also a remarkably valuable portion of national wealth in centrally planned economies. For example, in Poland, the book value of firms to be privatized was about eight times total private savings.
Since large state enterprises are such a large component of the economy in a typical newly democratic nation, they represent a key element in the transition to a market economy. Perhaps all economies are "mixed", in the sense that they contain some private enterprises, if only via a black or grey market, and also contain some enterprises either owned outright by the government or awarded heavily-regulated franchises. Even so, the "center of mass" of an economy along the private-public spectrum is of critical significance. One reason is because "private" enterprises contribute much more effectively than "public" enterprises to price discovery reflecting private rather than bureaucratic utility functions.
Therefore, the "private" versus "public" nature of an economy will strongly influence the realism of its pricing mechanism. A small number of "public" enterprises in a free economy may not cause a large amount of distortion, since they are embedded within an efficient pricing system. However, perhaps counterintuitively, a number of "private" enterprises in a controlled economy can cause severe distortion by arbitrage between the two regimes. An example of such arbitrage is buying up undervalued and therefore scarce resources in the controlled market, causing supply disruptions, in order to resell on the private market.
The result is that the fundamental nature of an economy strongly influences the effectiveness of its pricing mechanism. This results in a premium for early, concerted and massive privatization. Since large state enterprises so dominate the economy in a typical newly democratic nation, their privatization is essential to a realistic pricing mechanism and a market economy. Privatization of large state enterprises can also promote efficiency, competition, capital formation and dynamic management.
However, twin dangers in the privatization of large state enterprises have already rooted themselves in the Russian language: privatizatisiya (privatization) is already called prikhatisatsia (piratization), while the government-preferred term razgosudarstvleniye (destatization) ironically can also be interpreted as "the falling apart of the state." The public receptivity to, and willingness to bring about, privatization is also a valuable societal resource subject to dissipation. While privatization which is equitable, fast and effective can ultimately benefit almost everyone, right now privatization worries too many and benefits too few. Breakthroughs and novel approaches to privatization are needed.
Privatization of large state enterprises should be viewed as a major economic component of the new social contract being developed to substitute for communism, which promised "from each according to his ability, to each according to his need." Perhaps as part of a healthy historical trend to hold governments to the standards which they themselves have ennunciated, the dissolution of the Soviet Union has created the opportunity to achieve more fairness and egalitarianism than was ever approached during its 75 years of existence. This opportunity can be seized by allocating ownership in large state enterprises directly to the citizenry, with a minority interest retained by the state to finance social welfare. This would advance individual security by serving as a "safety net" of a meaningful amount of resources to people in need.
Universal distribution of ownership in newly privatized large state enterprises to an entire citizenry is equitable. This is because the resources of the entire society created and maintained those enterprises. Therefore, universal distribution is imbued with legitimacy. This perception of legitimacy has important positive feedback into social stability. In contrast, "spontaneous privatization" or "anarchic appropriation" is viewed as illicit, while the distribution of enterprises to their employees is perceived as randomly favoring a minority of workers who happened to have been dealt a winning hand by the central planning agency.
Besides being equitable, universal distribution of ownership in newly privatized large state enterprises is also fast. Property rights can be immediately established in the entire citizenry "at the stroke of a pen", without any first order wealth distribution effects based on the establishment of "enterprise boundaries." This can avoid a backlash caused by plundering associated with delays in assigning property rights. Speed is also essential for economic "Pareto" efficiency. Earlier achievement of irreversibility in privatization positively reinforces investment, thereby enhancing the sustainability of privatization as it evolves from the "noisy" to "mature" phase.
Universal distribution has many advantages in addition to equity and speed. It can simplify tax collection by levies against earnings of individual portfolios. If some enterprises with roots extending beyond current state borders have a corresponding transboundary distribution of ownership, that might be one element of an Economic Union. The cohesiveness of such an Economic Union could be affected by the apportionment of any governmental residual minority interest between an enterprise's new sovereign and the other new states, and by any preferential entitlement of local citizens. Universal distribution would also promote the evolution of gender roles by placing women on a more equal financial footing with men, thereby strengthening the social safety net by empowering the primary caregivers.
Vesting in the entire citizenry the ownership rights to privatized large state enterprises would immediately increase household wealth, and subsequently increase household income via dividends, encouraging individuals to spend more freely. This could provide a Kenyesian stimulus to help revive devastated economies. The transfer of resources directly to the citizenry would also provide capital for the small business sector, where even a moderate investment can create a large number of workplaces. Such incubation of numerous small private enterprises is essential to a healthy economy. In this sense, universal distribution serves not only as a "safety net" but also as a "trampoline", providing economic opportunity to individuals which directly enhances their personal liberty.
So far, other distribution schemes have been favored over universal distribution. In Poland, only 30% of shares are allocated to the citizenry, and even those are through financial intermediaries. Another 30% is reserved for Polish or foreign investors or the treasury, 20% goes to pension funds, 10% to commercial banks and 10% to enterprise employees. The Russian privatization program provides preferential options to workers and management for roughly 40-50% of the capital of an enterprise, with vouchers distributed to the public to bid for the balance.
The conventional wisdom is that universal distribution is a "non-starter" policy because of the need to accommodate stakeholders, the need for external discipline over management and the board of directors, and the difficulties of quickly achieving either privatization business plans or truly general individual ownership. It is therefore necessary to carefully consider each of these questions.
An enterprise by its nature involves stakeholders such as employees, pensioners, banks, creditors and local governments. By definition, business systems evolve an accommodation between stakeholders and enterprises--otherwise the class would not be considered a stakeholder. In most states, business systems are embedded within a matrix of more or less clearly defined legal rights and customary practices. Such an infrastructure of law and custom is not yet in place in newly democratic nations. One line of reasoning then concludes that it is necessary to accommodate stakeholders by distributing to them an interest in ownership.
However, blurring distinctions among stakeholders is counterproductive. The shareholders have ultimate control over an enterprise, and are entitled to its residual value. If all stakeholders were to be accorded this status proportional to their financial interest and political clout, then enterprise ownership would become a crazy-quilt patchwork of national and local governments, banks, creditors such as other enterprises, institutions, investors, board members, management, workers, and the general citizenry. Such an outcome would impose significant opportunity costs on household wealth and individual welfare. Unless the accommodated stakeholders usurp a sufficiently great windfall, this could even degrade their own welfare relative to more appropriately tailored financial support, by narrowing their portfolio and increasing its riskiness.
This classic example of a stakeholder is the enterprise employee. One concern has bene that workers unplacated by a sufficient ownership interest might sabotage an enterprise or otherwise thwart its privatization. However, once a decisive resolution to the allocation of ownership is reached, with a schedule to phase out enterprise subsidies, it is difficult to see how a worker would benefit by jeopardizing the source of this or her paycheck. A similar concern is that workers might quit to form their own company, in some form of "spontaneous privatization." To the extent such a process merely carries on the same business with the same clientele and capital equipment, it could be declared illegal and subject to the restitution of all subsequent profits to the state. However, to the extent that manpower is drained from inefficient, bureaucratic or monolithic organizations to new enterprises responsive to current market demands, that is a healthy process of "creative destruction."
Another common argument is that distribution of enterprise shares to employees is necessitated by their clout. But workers of industrial enterprises can be replaced if their demands become inequitable, especially during an economic depression with collapsed demand and increasing unemployment. Also, industrial workers represent only a small fraction of the citizenry. In Poland, such workers are only 30% of the labor force, and represent about 15% of the population. In the former Soviet Union, the largest 44,000 industrial enterprises employed about 35 million workers, representing only 12% of its population. In fact, worker ownership amounting to management control is a potential hazard which can degrade enterprise performance.
The allocation of stock to workers who happen to be employed at an enterprise on the date of its privatization is inadvisable, because it concentrates wealth randomly. However, an ongoing stock compensation plan for employees can be a legitimate component of compensation negotiations. Unlike the effectively random initial conditions of profitability as determined by a history of central planning directives, enterprise performance after privatization and hard budget constraints take effect will be strongly correlated to employee performance. In sum, the best way to accommodate enterprise employees in particular, and stakeholders in general, is to design a process of privatization which maximizes the prospects for the success of the enterprises in which they hold stakes.
It is worth quantitatively exploring the implications of two alternative scenarios in allocating ownership interest. Scenario 1 envisions distributions to the entire citizenry. Scenario 2 reserves 25% for workers of individual enterprises. In scenario 1, the workers of industrial enterprises as a class have 12% of all stock in the form of a portfolio, but in scenario 2 they have 12% of 75% of such "portfolio" stock plus 25% of the stock in their enterprise which aggregates as a class to 34% of all stock. From this perspective, the class of workers of industrial enterprises is almost three times a well off under scenario 2, and therefore could be expected to prefer it over the universal distribution of scenario 1.
In general, if the amount reserved for employees of large state enterprises equals the fraction R (e.g., 0.25), and such workers represent the fraction W (e.g., 0.12) of the population, then the ratio by which they, as a separate class, are better off than under a system of universal distribution is: EQU Relative Welfare of Workers at Large State Enterprises=(1-R)+W/R.
However, this perspective insufficiently distinguishes among affected classes and their relative interests. Since a considerable portion of newly privatized enterprises might fail or attain no significant stock market valuation, there are actually at least three relevant classes: "lucky workers" of industrial enterprises which succeed, "unlucky workers" of industrial enterprises which fail, and the rest of the population.
Under the pro forma assumption that half the enterprises fail, in order to award 6% of the population almost five times as much stock, 94% of the population is correspondingly made worst off by 25%. For perspective, assume a pro forma book value equal to eight times private savings, and a 25% minority interest retained by the government in a social welfare account. In that case, 94% of the population would see its average financial savings increase by less than five times while the lucky 6% would receive a windfall of almost thirty times average financial savings. In this case, a "lucky worker" would enjoy a relative advantage of more than 6 to 1 over other citizens. If even less than 75% of distributed stock vests in the entire citizenry, the resulting disparity would increase. The concentration of wealth by random redistribution of such a magnitude could erode the perceived legitimacy of capitalism and democracy, jeopardizing reform and social stability.
In general, the relative advantage of a "lucky worker" over other citizens is: ##EQU1## where R is a fraction of large state enterprise stock reserved for enterprise workers, S is the fraction of enterprises becoming successful, and W is the fraction of the citizenry represented by workers at large state enterprises.
Besides calling into question the legitimacy of the transition process, such a random concentration of wealth would represent an inferior economic strategy. While it is not possible to construct a single best social welfare function either by aggregating individual utility functions or even by examining societal choices, it appears that the increment to financial welfare of lucky recipients would be less than the decrement to financial welfare of the rest of the population. One reason is the diminishing marginal utility of increases in wealth. Another reason is because the enterprise stock is riskier in the lucky recipient's portfolio. The increased risk is due to the tripled exposure of an individual stock relative to the general market and also due to the dramatically high correlation between the value of a lucky recipient's enterprise stock (comprising over 80% of financial savings) and his or her job. This increased risk results in a higher implicit discount rate and a lower present value of the earnings stream. It would be more efficient, albeit transparently inequitable, to appease industrial employees by either direct cash payments or by simply increasing their proportionate share of stock in all enterprises combined. A better alternative would be for industrial employees to liquidate part of their allocation from a universal distribution in order to purchase shares in their employer, according to individual choice.
Another common objection toward universal distribution to the entire citizenry is that it would dilute ownership rights so as to preclude effective control over the board and management of an enterprise. The theory is that shareholders elect a board of directors accountable to them; the board of directors establishes broad policies and strategies, and appoints and oversees the chief executive officer (CEO) and perhaps other top management; the board of directors and top management have a collective fiduciary duty to conduct the affairs of the corporation in the best interests of the shareholders; top management hires officers which can speak on behalf of the enterprise; officers hire non-officer employees who can in turn form a supervisory hierarchy. If the results are unsatisfactory in the context of the competitive marketplace, then the board of directors is expected to remedy the situation--if necessary by replacing top management. If the board of directors fails to adequately serve the shareholders' interests, then the shareholders in turn elect different directors.
However, in reality the responsiveness of a western corporation to its shareholders is often inadequate. A series of common corporate tactics can entrench management and dilute effective shareholder control: inside directors (members of management also serving on the board of directors), golden parachutes (lucrative termination clauses in management employment contracts), proxy fights (management waging battles over shareholder votes adversely affecting its position) and poison pills (unpalatable corporate changes automatically triggered by a successful takeover). The disciplinary backstop is the capital marketplace, but takeover premiums of typically 50% demonstrate the insulation enjoyed by management.
Shareholder control over top management and the board of directors in the context of extremely widespread shareholdings can be facilitated by several policy choices: the modulation of corporation law, shareholder voting using polling techniques and the delegation of authority. Corporation law can reflect widespread shareholdings in several ways. To promote representation on the board by minority factions, directors can be elected by cumulative voting without unnecessary classes. Voting quorums can be set at low levels. Tender offers to take enterprises private can be encouraged by reducing the required thresholds of shareholder approval.
Shareholder votes can also be implemented with polling techniques. For a given decision, the enterprise would determine (consistent with applicable regulation) what percentage ownership represents the threshold between large and small shareholders. It would then submit the decision to each of the large shareholders, and a number of small shareholders selected at random. Each large shareholder vote would be weighted according to the number of shares voted, while each small shareholder vote would be weighted equally according to the total amount of small shareholdings divided by the number of small shareholders selected. However, the probability of a particular small shareholder being selected would be an increasing function of the number of portfolio shares. Statutes and regulations can specify maximum thresholds and minimum polling sample sizes as a function of the size of the enterprise and the importance of the decision.
Shareholder control can also be concentrated by delegation of authority. Delegation of investment authority can provide market discipline as delegatee-organizations perform investment research resulting in the sale of shares of under-performing enterprises. Sales of a particular enterprise's shares would tend to depress the share price, reducing the value of compensation shares to the management or workers. Recipients of compensation stock in well-performing enterprises would likewise be rewarded by share purchases increasing the stock price. Delegation of voting authority can also concentrate shareholder control by serving as an on-going and comprehensive "proxy" delegation.
Another very powerful way to align the interests of shareholders, top management and the board of directors is to tie executive compensation to the stock market valuation of the enterprise. The idea is to determine by statute that a CEO's annual compensation is a fixed multiple of national average wages, plus a fixed percentage of total outstanding shares to be issued from the enterprise treasury. Corresponding formulae for the board of directors, president and perhaps executive vice-presidents would be incorporated into the privatization business plan. This approach can be characterized as an emergency incomes policy designed to align the interests of the board and management with the interests of the shareholders. While incomes policies are generally defined to be anti-inflation devices, the sense of curbing exploitation of inherent market power would apply here.
Fixing CEO compensation as a multiple of national average wages plus a percentage of total outstanding shares has empirical support from the experience in a mature market economy like the United States, where CEO annual compensation can be expressed a a linear function of stock market valuation. This functional relationship between CEO annual compensation and stock market valuation is equivalent to:
CEO annual compensation=26.3.times.(national average wage) +0.0034% of (stock market valuation)
This reflects a high "base" U.S. executive compensation and a relatively low percentage of average total salary--14.5%--associated with stock market valuation.
Associating 100% of U.S. CEO annual compensation with stock market valuation while keeping the same average CEO compensation yields: EQU CEO annual compensation=0.023% of (stock market valuation)
In general, to associate S % of CEO compensation with stock market valuation, while deflating the average CEO compensation to D % of U.S. practice, the following formula should be used: EQU CEO annual compensation=26.3.times.D%.times.[(100-S)/85.5].times.(national average wage) +0.0034%.times.D%.times.(S/14.5) of (stock market valuation) .
For example, the associating 80% of compensation with stock market valuation, and deflating average compensation to 50% of U.S. practice, yields approximately: EQU CEO annual compensation=3.times.(national average wage) +0.01% of (stock market valuation)
Two issues of validity arise in the foregoing analysis: the linearity and the meaningfulness of the association between CEO compensation and stock market valuation. Addressing first the issue of linearity, the best alternative to a linear correlation is a correlation between the logarithms of the two variables. Indeed, in the original sample of 216 points, the correlation coefficient of the two variables was just 0.258, while the correlation coefficient of their logarithms was 0.523. However, restricting the range of CEO compensation ($300K to $1,600K) and of stock market valuation ($300M to $30,000M), and thereby excluding the four highest and lowest instances of each variable, yields a sample of 200 observations with roughly comparable linear (0.484) and logarithmic (0.547) correlation coefficients.
Next, the nature of any non-linearity can be assessed by performing regression analysis on sample sets of the data stratified by stock market valuation. The regression coefficient (of the independent variable--also stock market valuation) is 0.0034% for the entire data set, 0.0081% and 0.0022% for the lower and upper halves of the stratified data set, and 0.241%, 0.0206%, 0.0068%, 0.00064% by ascending quarters. The pattern of coefficients decreasing as stock market valuation increases strongly suggests nonlinearity. However, the coefficients are 0.00065%, 0.0064% and 0.0013% by ascending thirds, eroding confidence in the robustness of any such pattern.
In addition, stratifying the data by the number of employees fails to demonstrate any need to compensate for enterprise size. The regression coefficient (of the independent variable--stock market valuation) is still 0.0034% for the entire data set, but becomes 0.0027% and 0.0025% for the lower and upper halves of the stratified data set, and 0.119%, 0.0018%, 0.0045%, 0.0018% by ascending quarters. The lack of any strong pattern here is particularly significant, since reasonable estimates of the number of employees of a newly privatized firm should be available--unlike for estimates of stock market valuations. It seems fair to conclude that while there may well be nonlinearity, over a suitably restricted range a linear approximation is statistically defensible in the context of an emergency incomes policy. This is particularly cogent, because it is a linear association which allows compensation to be set at a base rate plus treasury stock equal to a fixed percentage of shares, entirely avoiding the need to value the compensation shares.
In addressing next the meaningfulness of the association between the two variables, it should be noted at the outset that stock market valuation is not represented as solely determining CEO compensation in U.S. practice. It can also to a degree serve as a functional surrogate for other collinearly related variables. To explore this issue, a cross-correlation matrix [was calculated] for CEO compensation, stock market valuation, age of CEO, years with company, years as CEO, profit, sales, assets, number of employees, an index of diversification into related industrial sectors. Stock market valuation is clearly the independent variable with the highest correlation (0.48). This conclusion is robust even using the logarithm of (either or both of) the CEO compensation and the "extensive" independent variables (sales, assets and number of employees (but excluding sometimes-negative profit)). It is possible that the significant correlations between stock market valuation and profit (0.46), sales (0.66), assets (0.63) and number of employees (0.53) increase the explanatory power of stock market valuation. However, the low correlation coefficients between the residuals (from the regression of CEO compensation versus stock market valuation) and the unused independent variables support the conclusion that it is not necessary to include multiple variables for a meaningful regression estimate.
While stock market valuation explains CEO compensation better than the other factors considered, the correlation remains imperfect. Therefore, if there is no "random" component to compensation, unconsidered factors play a significant role. Clearly, policy-makers need not go to any great length to preserve the influence on compensation of factors such as any network of reciprocity between CEOs and the compensation committees of boards, when such a network is not positively correlated to the economy. However, a sophisticated marketplace for management employment undoubtedly takes into account significant and meaningful factors which are perhaps quantifiable only in the salary outcome itself. But it may unfortunately be likely that in many newly democratic nations, self-serving reciprocal networks are liable to have a greater effect on compensation than sound judgment calls concerning the unquantifiable characteristics needed to successfully lead enterprises into a newly-free marketplace.
At any rate, the point is that setting CEO compensation as a multiple of average wages plus a percentage of outstanding shares is not prescribed as an optimum approach for mature market economies. Rather, it is proposed as an emergency incomes policy to align management and shareholder interests in furtherance of a critical policy objective: privatizing large state enterprises as rapidly and effectively as possible.
Stock compensation would begin upon the privatization date specified in a business plan approved by some sort of Privatization Board. Vesting of accrued shares would occur only upon certification by the Privatization Board that any demonopolization goal which it had stipulated had been achieved. To further reduce the possibility of monopoly rent accruing to management or the board, the Privatization Board could confiscate a percentage of accrued compensation shares corresponding to its estimate of the proportion of the enterprise market valuation which arose from monopoly rent subsequent to privatization. An exception would be that no confiscation would be allowed if demonopolization were achieved within a "safe-harbor" time interval. To encourage successful spin-offs in the process of demonopolization, the motivation to retain as large as possible a stock market base should be reduced. Therefore, a spin-off should pay a corresponding cash bonus to its parent's board and management team (as of the spin-off date), by issuing and selling on the market its own treasury stock. Statutory compensation stock could eventually be terminated by individual enterprises by the choice of a sufficient plurality of shareholders.
To complement a statutory incomes policy for CEO annual compensation, the alignment of the interests of the board of directors and the rest of management with shareholder interests via compensation can be operationally achieved in the privatization business plan for each enterprise. Allocating the non-CEO portion within the privatization business plan would preserve the flexibility to adapt the compensation plan based on the number and stature of directors and executive vice-presidents. Those executive vice-presidents would also be ideally placed to become CEOs of spin-off companies, as enterprises transform from "u-form" to "m-form."
Any inclination to begrudge compensation as a percentage of stock market valuation for even very large firms should be resisted. Enterprise size is not a definitive determinant of stock market valuation. For example, the stock market valuation of 17-year-old Microsoft, with 10,000 employees and sales of $1.8 billion, is now as great as that of the world's biggest manufacturer: 84-year-old General Motors with 766,000 employees and sales of $124 billion. This is because the stock market more or less reflects the present discounted value of the expected stream of future, after-tax earnings. The boldness and initiative of top management, which would be strongly encouraged by unlimited upside potential, will play a vital role in determining which enterprises become highly valued and which ones fail. While 0.01% of stock as a component of annual compensation can strongly motivate the CEO of a very large enterprise, it is a very small price indeed relative to the potential return to shareholders.
One concern is that privatization business plans just won't happen, due to resistance. However, the enterprise leadership responsible for preparing the plan would presumably be heavily represented in the subsequent treasury stock compensation pool. It would therefore be highly motivated to rapidly achieve the privatization and demonopolization milestones--stock compensation "start" and "vesting" respectively. Since the enterprise leadership is capable of providing incentives or disincentives to key employees even in the preparation phase, resistance can be minimized.
Indeed, a healthy tendency may arise for relatively dynamic managements to rapidly formulate business plans including contiguous and desirable organizational subunits before they are claimed by a potential competitor. There may be a corresponding "spontaneous liquidation" of undesirable and unclaimed interstitial organizational subunits. Therefore, dynamic management teams enthusiastically supportive of privatization will tend to acquire control over the salvageable portions of the organizational infrastructure. In the meantime, maladaptive state enterprises will atrophy as subsidies are phased out and already-privatized enterprises refuse to imprudently extend credit. As a consequence, both the markets and the production factors of maladaptive state enterprises will become available to the private sector.
Another concern is that it could be impractical to quickly generate privatization business plans. This issue can be analyzed by exploring what such plans should contain, and how they can be generated. The privatization business plan should contain a selective update of currently available information, a list of claimed physical facilities, and a comprehensive if provisional organization chart including all available names. The generation of such privatization business plans is potentially a highly leveraged focal point for international assistance. Western academics, businessmen, lawyers or accountants, assisted by students or trainees in related fields, could provide guidance along with access to portable computers and menu-driven software for expedited diskette submittals.
The privatization business plan should also attempt to identify potential "interferences", or potential boundary disputes with other enterprises. The full disclosure of such potential interferences would help demarcate inter-enterprise boundaries. The enterprise making the disclosure would be rewarded by a stronger presumption of validity for an approved business plan. Otherwise, a conflicting privatization business plan filed within a certain period of time by a "contiguous" enterprise might possibly be awarded part of the first enterprise.
Privatization business plans can be simplified by statutory resolution of certain major--yet highly uncertain--potential rights and duties. Each enterprise should be subjected by law to the "polluter pays" principle for future, and only future, liability. This clearly locates future environmental rights in the public, while maintaining societal responsibility for past environmental damage. Another major issue is interenterprise debt. It could be reasonable to discharge such debt upon privatization, since it largely reflects a legacy of distortions resulting from central planning. The net result is a newly private enterprise able to write its future on a clean slate. Such an enterprise can attract risk capital as a viable investment opportunity.
Universal distribution can be simplified by allocating each citizen a single "Stock Market Unit" (SMU), consisting of the right to one share of each enterprise privatized within some initial period, such as by the end of 1993. This asset is designed to be fungible and liquid. To motivate enterprise leaderships to privatize within that initial period, the statutory treasury stock compensation pool for the board and top management should be significantly reduced for any necessary follow-on interval. Such a follow-on interval would have a corresponding tranche of "SMU2s". Therefore, part of the fluctuation in value of a SMU before its cut-off date would arise from changing expectations about the extent and timing of future privatization. SMUs would be a market index of expectations about future privatization prospects, and would help create a nationwise constituency for fast, massive and effective privatization.
This approach is more practical than either standard auctions or voucher schemes. A big problem with auctions is the absence of sufficient capital willing and able to bid realistically. Auctions can also be dominated by pools of capital raised by organized crime or through "spontaneous privatization", undermining the legitimacy of the transition to capitalism. In contrast, the SMUs represent a distribution of capital to the entire citizenry, not only obviating the problem of insufficient capital, but bolstering the legitimacy of transition as well.
Nor are the problems associated with auctions completely cured by voucher schemes. While vouchers can also be universally distributed either gratis or at nominal prices, they impose a major information burden. Many of the citizens missed in voucher schemes are precisely those in the most need, such as the illiterate or homeless. Vouchers also require the bidder at auction to value individual enterprises without a time series of reliable accounting data and in the context of major social upheaval. This problem is magnified because the information burden comes with time deadlines. Vouchers are wasting assets, becoming worthless after the corresponding auctions.
In contrast, SMUs provide a relatively stable investment imposing a minimum information burden without deadlines. They are more stable because they represent an entire portfolio, rather than a single enterprise. The information burden is reduced to the decision whether to keep, sell or buy more SMUs at the current market price. Since SMUs would be a major standardized asset, price discovery and dissemination should be more effective than for a myriad of individual enterprises. Each participant in the SMU market would then be a beneficiary of the price discovery achieved by the market's most sophisticated participants.
The absence of deadlines is fundamentally significant to the impact of SMUs. A legitimate and perhaps quite sophisticated strategy can be to simply hold them and collect the dividends. Since the original distribution is liable to resemble low-priced out of the money call options with extremely uncertain valuation and high implicit discount rates, a "hold strategy" will allow recipients to reap the capital appreciation as the society stabilizes, leading to falling risk premia and implicit discount rates. The alternative is for that appreciation to accrue to sophisticated risk capital, with adverse distributional effects. To constrain the rate at which people make investment mistakes, vesting intervals such as 20% a year for five years could be imposed on alienability. This could correspond to the expected learning curve in the society, while stabilizing the market by avoiding sudden oversupply. However, to accelerate portfolio adjustments, stock ownership concentration, and a reversal of the communist legacy of "learned helplessness", immediate vesting may well be preferable.
The distribution of SMUs can take the form of either script or of a book-keeping entry of the entitlement in a computer system. A particular subclass of citizen such as adults could be provided the option to claim a certain percentage of the entitlement in the form of script. This script would be stamped each year upon claiming the accrued aggregated dividends of the underlying portfolio of enterprise shares. Since this script would represent a store of value and might well become to a degree a medium of exchange, it could be viewed as a quasi-currency. While it would fluctuate with the stock market value, it might represent an inflation hedge against debasement of the official currency, enhancing the ability of the government to control inflation. It would also facilitate price discovery for SMUs, as large numbers of individuals engaged in daily transactions at fluctuating market prices.
However, the major form of distribution of SMUs can be as an entry in a computer system. Such a system can present to the entire citizenry a much wider range of investment opportunities. Such breadth of individual choice is valuable. Citizens should be free to bid portions of their SMUs along with cash and mortgages at privatization auctions of small state enterprises such as shops. Each individual should have the opportunity to exchange SMUs for selected foreign currencies, government debt, shares or debt of a specific enterprise and annuities. The government can use the residual minority interest in enterprises kept in its social welfare account as a capital base to insulate its budget from the actuarial uncertainties of such annuities, and to underwrite insurance for private financial institutions selling such annuities as principals.
As part of the social safety net, part of each individual's entitlement to ownership in large state enterprises could be placed into a restricted "social security" subaccount. The only allowed investments in this account could be SMUs, government debt or lifetime annuities, although provisions can be made for withdrawal in cases of hardship. While it is unrealistic to expect such a social security subaccount by itself to secure the financial future of indigent citizens, it may be a helpful resource, especially for the elderly.
As some of the most vulnerable citizens in a society, children should be entitled to a share. A child's share should remain inalienable until his or her majority, except for health or education needs. A corresponding allotment for children born in the future should not be funded by enforced new share creation, which could debase the market. However, it would be possible to fund such allocations for future births by means of a wealth or income tax.
To help fund welfare programs for the homeless, indigent or incapacitated, the local or regional governments can be allotted SMUs corresponding to an estimate of the number of citizens who are missed in the registration. Any citizen registering after a certain grace period such as a year would obtain his or her entitlement out of the account of the local or regional government, motivating it to register everyone fast to maximize both regional welfare and its own funding base. Combining registration for entitlement to stock rights with voter registration could even provide positive economic reinforcement to the democratic process.
Appropriate initial logistical constraints can ensure practicality. Transactions by individuals executed by the government are entered over the period of an investment cycle, which could initially be as long as a year. Transactions can be mailed or submitted in person, to either a local or central registry. As financial institutions and the societal infrastructure develop, telephone orders could be placed to brokerage houses which would guarantee authenticity, and relay the transactions to the central registry. Transactions are progressively combined and sorted by a hierarchy of computer centers, resulting in a comprehensive transaction data base. At this point, the central computer facility processes the transactions, calculates market-clearing prices, and updates portfolios with current asset accounts. Even half a terabyte of storage, enough for a per capita storage allocation of five kilobytes in a population of one hundred million people, would cost under one hundred thousand dollars.
The first step is to formulate a privatization strategy. This need not be a master plan attempting to inappropriately specify choices in advance of future uncertain events. Rather, it should establish the direction of the privatization policy and fix property rights, while preserving the flexibility to deal with future uncertainty.
The first element of privatization strategy is the choice of distribution technique, whether auction, voucher or universal vesting. Immediate universal vesting of the future interest in privatized large state enterprises (i.e., SMUs) is the policy of choice. Universal distribution is equitable, fast and effective, and its achievement by automatic vesting is more practical and equitable than voucher schemes. The universal vesting must be apportioned between rights to script and computer accounts. At least some portion of the SMUs could be available in script form, to solidify public support, facilitate price discovery and inhibit inflation. Once a distribution technique is determined, recipients must be identified. Potential recipients include citizens, workers, management, banks, pension funds, charitable institutions, local or regional governments, in addition to a portion being retained by the national government. One effective policy would reserve a minority interest to the appropriate levels of government in social welfare accounts, and distribute the rest to the entire citizenry. This series of choices is important to make early, since the establishment of property rights is a precondition to an effective market economy.
After property rights are established, another series of policy choices must be made. If a computer system is implemented to support universal vesting of SMUs in all citizens, then the eligible investment opportunities must be specified. Alternatives include government debt, other debt including annuities, enterprise shares and foreign currency. Then the types of transactions on the assets which the system will support must be specified. In particular, the structure of any method of delegating investment authority must be addressed.
Finally, timing must be addressed. Some timing issues must be determined at the outset, such as the cut-off privatization date for enterprises to be included in SMUs. Others should also be resolved right away, such as the period after which new registrants such as the incapacitated or homeless would be allocated their portion out of a local or regional governmental account. But some timing issues can be resolved later, such as the safe harbor time interval for achievement of demonopolization goals without subjecting previous management or worker compensation stock to partial confiscation.
Upon formulation of a privatization policy, the appropriate parts must be promulgated into law by legislation, decree or agency regulations. For example, a legislature could establish that each citizen is entitled to one Stock Market Unit (SMU) representing one share in each large state enterprise privatized before the end of 1993, an additional 1/4 SMU to be held in a restricted social security subaccount, 1/10 SMU to be available to adult citizens as script upon registration (but with the option to leave it on account), and one SMU2 corresponding to subsequent privatizations during the first follow-on interval. As another example, legislation or decree could promulgate an emergency incomes policy whereby each CEO of a newly privatized large state enterprise would be paid the equivalent of three national average wages plus enterprise treasury stock equal to 0.01% of shares outstanding.
Once the initial planning is completed and legislation has been enacted to define the fundamental outlines of a privatization strategy, the system must be implemented. As the policy apparatus of a country analyzes the changing situation and the policies of the national government evolve, additional legislation and decrees will be needed. To facilitate government management of a complex and challenging process, authority can be delegated to an agency such as a Privatization Board to review privatization business plans, promulgate regulations and oversee demonopolization.
Besides the legal and regulatory structure, it is necessary to actually establish the systems to carry out the privatization strategy. These include personnel systems to input and validate transactions, security systems to prevent embezzlement or privacy violations, and computer systems to process the transactions. Lessons learned from the cycle of operation, maintenance and adaptation will then feed back into regulation and legislation.
One way to structure an implementation strategy is by means of PRIVATIZATION PLANNER.TM. (a system to help plan for privatization) and PRIVATIZE!.TM. (a new system to achieve universal privatization). PRIVATIZATION PLANNER.TM. (a system to help plan for privatization) provides a systematic overview of key policy choices in the privatization process. PRIVATIZE!.TM. (a new system to achieve universal privatization) sets out the design of a computer system to advance privatization and free markets. In combination, they support the development and the implementation of a privatization policy such as universal vesting of SMUs.
Different groups will have different roles in the proposed system. The government is responsible for formulating privatization policies and overseeing their implementation. This initially involves legislation or decrees which resolve property rights, establish a management incomes policy as appropriate, and delegate authority to an agency to oversee the privatization process. Subsequently, that agency must promulgate regulations to provide guidance to and constraints upon the process. For example, professional organizations which accept investment authority over part of a portfolio in return for a share in the profits or assets could have a limit on the rates they charge. The agency itself must in turn be overseen by the legislature, executive and/or courts, who are in turn responsible to the citizenry in whom the entitlement to SMUs was created.
Enterprise management must first develop a privatization business plan. This will often involve a search for identity, as leadership concentrations in an interwoven industrial infrastructure determine where their organization ends and their suppliers and customers begin. A key step in this phase is the emergence of a CEO, board of directors and top management, along with their stock compensation agreements. This process should involve interaction with the Privatization Board, so that the resulting privatization business plan is likely to be the product of negotiated decisionmaking, rather than the start of regulatory confrontation. In the case of heavily concentrated industries, executive vice-presidents should be placed in positions to coalesce any spin-offs needed to achieve demonopolization goals required by the Privatization Board.
The Privatization Board may be authorized or directed to consider wage compacts as part of the Privatization Business Plan, in order to cushion the shock of transition on workers. This is inadvisable if workers have already received SMU entitlements including social security subaccounts, since it would constrain management from maximizing the value of the enterprise to its shareholders--the entire citizenry. However, management and workers should both seriously consider including stock compensation as part of wage negotiations.
Upon privatization, enterprise management can begin to accrue compensation stock. Vesting of such stock should be deferred until the Privatization Board has certified demonopolization. If demonopolization occurs after a safe harbor time interval, the Privatization Board should confiscate the part of management and worker compensation stock which it estimates to be attributable to monopoly rent arising subsequent to privatization. Spin-offs which survive an initial interval should liquidate a number of treasury shares determined by Privatization Board regulations and pay the proceeds to its former-parent organization's management as constituted at the date of spin-off.
Enterprise managements can also ensure that their organizations serve as data entry foci into the computer system. Enterprises would generate transaction data for their own portfolio, and records of employees along with negotiated stock compensation amounts. In addition, enterprises can serve as data entry centers for transactions by their employees, and perhaps on a compensated basis even for other members of their local community.
The proposed system places all citizens into the role of portfolio owners. As such, they are capable of evaluating alternative investments and entering transactions at local registries or enterprises.
While part of each owner's portfolio would remain on account with the government (for instance, at least the social security subaccount), the remainder could be transferred to the individual's choice of financial institution for safe-keeping and access.
From the perspective of processing centers, each is a node in a hierarchical network of information flow. Each center receives transaction data from different sources, sorts and combines that data, and passes it to the next higher node. The lowest nodes may receive virtually all transaction data from paper forms requiring data entry. Progressively higher nodes such as regional centers would typically handle as input the diskettes or tapes generated by the lowest nodes, and then send a single set of tapes on to the the next higher node. Eventually, a single composite transaction data base is produced at a central processing facility. This data base is then processed to execute transactions as appropriate, and the results transmitted to custodial financial institutions.
Confusion inevitably accompanies great social change. In particular, the transition from centrally planned economies to free markets involves the deprogramming of decades of indoctrination. Basic concepts are alien. The "invisible hand" of Adam Smith seems a fairy tale. Profits all seem illicit. Private property seems anti-social. Initiative seems dangerous, while the danger of joblessness and poverty is frightening. The result can be bewilderment, and inconsistent or even directionless policy.
The implementation of the proposal for universal vesting of the future interest in privatized large state enterprises will be associated with more confusion. The concept of vesting an intangible future interest may seem novel. The different participants in the system--government policy makers, enterprise management, portfolio owners and processing centers--may not at first fully understand their respective duties and options.
The antidotes to confusion are clear policy directives, education and training, and patience. Each of these antidotes can be available. The universal vesting of the future interest in privatized large state enterprises may be novel, but it can be sold with clarity to a public in search of a legitimate system leading to better living standards. Education and training have international and domestic aspects. Exchange programs where citizens of newly democratic nations travel abroad to learn while members of successful democracies take their place to teach are already growing in scope. On the domestic side, while there is typically a dearth of teachers qualified to teach advanced courses in western business practices, the educational infrastructure is in many cases a strong asset capable of redirection. Finally, a certain interval of time is needed to successfully navigate such an expanse of social change, so patience is essential.
The proposed policy involves the development of personnel systems, security systems and computer systems. All can be associated with notorious delays. Delays erode credibility, and credibility is the coin of democratic government.
Two factors mitigate this problem. First, actual property rights can be created immediately upon the promulgation of universal vesting. These property rights are real, and could immediately be used to bid at auctions of shops, flats, land, government equipment and other state property. Script for a portion of the new property rights could be issued right away to tangibly demonstrate the transfer of wealth from the government as custodian to the individual citizens as owners. Second, any delay in operationalizing the personnel, security and computer systems will not impair the new asset--alternative investment choices will only be deferred. If the initial delay coincides with a period of stabilization, then exorbitant discount rates could be punctured and share values could increase, to the benefit of the citizenry. At any rate, the challenge in such an endeavour and its potential advantages would be no secret, and given the opportunity, a society collectively can have great sophistication in its evaluation of the performance of a government.
The other answer to delays is priority. One weakness of centrally planned economies has always been the inability to handle well the myriad simultaneous decisions facing a modern society. On the other hand, they often have demonstrated the capacity to do "any thing." That is, given enough priority, a particular objective could be achieved in world-class fashion. If the transition to democracy goes hand in hand with free markets, and if free markets are contingent upon privatizing large state enterprises, it would seem appropriate for policy makers to allocate the human and material resources to achieve that goal as rapidly and effectively as possible.
It can be assumed that every possible error will happen. Fictitious citizens will be registered. Homeless, incapacitated and illiterate citizens will be missed. Actual portfolio owners will request transactions they don't mean. Data entry personnel will input transactions other than directed. Intermediate processing centers will lose segments of the transaction data base. The central computer facility will encounter software and hardware glitches, and operator errors. Choice of delegatee-organizations, choice between alternative orders, and matching buy and sell orders will occur at approximate prices. Assets intended to be transmitted to custodial financial institutions will be delayed or lost. At each stage of the process, individuals outside government without authorized access and individuals within government with authorized access will attempt to use information improperly. While each of these problems occurs in mature market economies as well, it can be expected that their magnitude will be greater in newly democratic nations.
However, problems will occur with any privatization policy, and the proposed policy can effectively address problems which do arise. Standard audit practices can raise the cost of fictitious registration: requiring local authentication at initial registration, random checking of the legitimacy of registrants, analysis of data for suspicious patterns, penalties assessed against the social welfare allocation of local governments with poor records in allowing fictitious entries, and restitution of falsely claimed assets with additional penalties corresponding to the number of false registrations likely to be missed. Allocating late registrants (e.g., a homeless person registering after a year) their entitlement out of the local government's social welfare portfolio will encourage it to initially miss as few as possible.
To prevent portfolio owners entering transactions they don't mean, information can be distributed to clarify choices. Still, some mistakes are part of the tuition in traversing the learning curve. If data entry personnel enter erroneous records, they can be canceled. If segments of the transaction data base are missing, the regional centers can attempt to validate completeness and request missing segments. When errors are caught, any consequential loss sustained by the portfolio owner can be made good out of the responsible government's account, which would likewise accrue any consequential gain.
At the central computer facility, processing disruptions may necessitate recovery procedures such as reprocessing from the latest backup. Software glitches may be identified and patched. The degree of price approximations will be a function of processing power available, more a function of western export licenses and international agency support than technological constraints. Transmittals to custodial financial institutions will be backed up and available for retransmittal as necessary. Improper use of the information data bases can be dealt with by law, so that what could have been Orwellian technology can instead be harnessed in the interest of economic security and individual liberty.
A fundamental advantage of the policy to universally vest future privatization interests is the immediate resolution of ownership rights. While the wealth transfer may seem intangible until distributed as script, used in a bid at auction, or accessible with a computer system, it is real nonetheless. It can boost current household wealth and future household income, providing a non-inflationary stimulus to the economy.
The proposed policy is superior to alternatives which include as recipients entities other than governments or citizens (e.g., enterprise employees). One reason is that to a first order approximation, with universal vesting the establishment of inter-enterprise boundaries does not affect wealth distribution. Indeed, it becomes in the interest of the citizenry and the hierarchy of governments to approve enterprise boundaries which maximize their aggregate rather than individual worth.
Universal vesting also provides an important safety net to individual citizens. The social security subaccount of an individual's portfolio can be restricted to portfolio stock, government debt or lifetime annuities. In case of hardship, withdrawals could be authorized for medical or living necessities. The allocations to children can provide needed support, finance education and help prevent intergenerational poverty cycles. In the process of providing an individual safety net, the social security subaccount will also reduce the social welfare burden on future government budgets.
The unrestricted portion of a citizen's portfolio is a valuable patrimony. It can be used to bid at auctions of small state enterprises, start a business, relocate a family, buy land or make alternative investments. While some individuals may be shrewder or luckier, all can receive the same economic opportunity. The result can unleash the economic power of decentralized decisions conforming to each individual's personal utility.
Universal vesting of future privatization rights can promote free markets. It can be instrumental in the rapid and effective privatization of large state enterprises, which is essential for valid price signals. It can create opportunities for alternative investments such as foreign currencies. It can also promote capital formation by accelerating the creation of markets in individual enterprises, accessible to citizens and foreign investors alike.
The proposed system incorporates the concept of promoting the transition to private financial institutions. Individuals can transfer assets (except perhaps from the social security subaccount) into approved custodial financial institutions of their choice. This can increase privacy, speed access and promote the ability to rapidly update investment strategies. This can also provide a source of capital to new financial institutions, which can then serve as capital intermediaries to enterprises in growth industries.
Wealthy democracies can play an influential role in the transition of newly democratic nations. But where do their interests lie? The spectrum of issues can be resolved into three interconnected and fundamental components: economics, national security and core values.
Russia by itself has a foreign debt of about $80 billion. It has stated it can only repay two to three billion dollars of the eight billion due in 1993. Any policy which stabilizes the economies of newly democratic nations and helps them grow will directly increase the value to the west of their foreign debt, while increasing the stability of the international financial system.
More broadly, the formula for western prosperity since World War II has been the Bretton Woods policy triad: progressively freer international trade, structural adjustments for progressively more flexible and responsive domestic economies, and medium-term domestic price stability. While the results have reflected the uneven application of this formula, it represents a viable objective for consensus in the current situation of global flux. From an economic perspective, it is in the interest of the west to include newly democratic nations in a system of progressively freer trade, as they progress towards market economies and more stable price systems.
Protectionism is not a sound economic argument to fear new or succesful market economies. To some, there may seem to be an historical analogy with post-war Japan or Germany, reconstructed with American support. However, the emergence of these states as economic and political leaders has been hailed as a major success of American foreign policy, despite the resulting economic competition. All nations can benefit from additional trading partners, even if newly emerged from autarky. This results from Ricardo's theory of comparative advantage: the new trading partners will be suppliers of goods or services for which they have a relative production advantage, they will provide new markets for goods or services for which they have a relative production disadvantage, and the exchange rate will appropriately adjust relative real incomes as a function of relative productivity. The resulting potential for mutual and real economic gain takes on added significance as even leading industrial nations struggle to raise their standard of living.
The linkages between the theory of comparative advantage and the Bretton Woods policy triad are clear. Newly democratic nations need price stability to fully participate in the global economy. As their participation grows, trade patterns will change and even successful market economies must flexibly adjust. To ensure equitable distribution of the gains which the theory of comparative advantage promises, international trade must be made progressively more free.
The transition of newly democratic nations to market economies has mixed implications for the national security of wealthy democracies. On one hand, there is a strong correlation between economic development and stable democracy, which in turn is empirically related to peace. On the other hand, newly democratic nations remain potential adversaries for which economic power could become a weapon of critical importance. Since economic power can be wielded as a weapon largely independently of military force, studies showing that only a minor amount of the variation in military force structure is explained by discretionary wealth are not dispositive. The United States has reacted to these mixed implications by adopting a policy which hedges against future uncertainty.
Any analysis of the western interest in aiding newly democratic nations should properly weight the importance of core values. Values are an integral aspect of national security. One list of fundamental American values includes self-determination, the dignity and worth of the individual, and the accountability of those in power to the people as the basis for international policies, implying that systems professing these values should be fostered. The Judeo-Christian heritage has provided the moral foundation for these American values.
Perhaps the most powerful nation-state in the world, together with its allies, can afford the risk of energetically aiding the transition of newly democratic nations. By fostering western values, the wealthy democracies would in a fundamental sense be reinforcing their own identities. Perhaps the scoreboard of democracy, up to 62 countries representing 44% of the world's population, can gain momentum as the half-way mark is passed. If fear of the Other is such a potent source of hostility, then perhaps the best way to make the world safe for democracy is simply to make the world itself democratic.